CIMA CO2 Official Learning System - Fundamentals of Financial Accounting
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STUDY MATERIAL C2
30
THE FRAMEWORK OF FINANCIAL STATEMENTS
reduced his capital but not his profi t. There are lots of other reasons why profi t does not always
result in an equal change in bank and cash balances. You will look at these in Chapter 13.
2.7 Capital and revenue
Note also that we do not include the cost of non-current assets in the profi t calculation.
We only include expenses that have been consumed, and have no future benefi t for the
organisation. Non-current assets have not been consumed, and do have a future benefi t, as
they will be used to earn profi ts in the following periods. This is why they are shown in the
statement of fi nancial position rather than in the income statement.
2.7.1 Capital transactions
The word ‘ capital ’ means different things in different contexts. You have already seen how
the word is used to identify the investment by an owner in his business. Capital transac-
tions are those that affect the organisation in the long term, as well as in the current period.
Capital expenditure is expenditure on non-current assets, and capital receipts would result
from the disposal of those assets. Other transactions that are regarded as capital transactions
are the obtaining of, and repayment of, non-current fi nance. Capital transactions initially
affect the fi gures in the statement of fi nancial position. Of course, non-current assets are used
up over a number of years, and so eventually they will be consumed. We account for this by
including depreciation in the income statement. You will look at this in detail in Chapter 6.
2.7.2 Revenue transactions
Revenue transactions are those that affect the organisation in the current period. Revenue
receipts come from sales, and sometimes in the form of income from investments. Revenue
expenditure is expenditure on items that are consumed in the period, for example the run-
ning expenses of the organisation, cost of sales and so on. Revenue transactions affect the
fi gures in the income statement.
2.8 Summary
In this chapter you have:
●
seen how the separate entity convention works – for accounting purposes, a business is
always regarded as an entity separate from its owners;
●
seen how the accounting equation is defi ned as:
Assets Liabilities Capital
and how it changes as a result of fi nancial transactions;
●
learnt how to use the accounting equation to draw up a simple statement of fi nancial
position after certain transactions have occurred and how to prepare a statement of
profi t, including a calculation of cost of goods sold;
●
learnt that profi t does not always result in an equivalent change in bank and cash balances;
●
that transactions can be classifi ed as either ‘ capital ’ or ‘ revenue ’ according to whether
they affect the statement of fi nancial position or the income statement.
31
Question 1
1.1 Gross profi t for 20X1 can be calculated from:
(A) purchases for 20X1, plus inventories at 31 December 20X1, less inventories at
1 January 20X1.
(B) purchases for 20X1, less inventories at 31 December 20X1, plus inventories at
1 January 20X1.
(C) cost of goods sold during 20X1, plus sales during 20X1.
(D) net profi t for 20X1, plus expenses for 20X1.
1.2 The capital of a sole trader would change as a result of:
(A) a payable being paid his account by cheque.
(B) raw materials being purchased on credit.
(C) non-current assets being purchased on credit.
(D) wages being paid in cash.
1.3 The ‘ accounting equation ’ can be rewritten as:
(A) assets plus profi t less drawings less liabilities equals closing capital.
(B) assets less liabilities less drawings equals opening capital plus profi t.
(C) assets less liabilities less opening capital plus drawings equals profi t.
(D) opening capital plus profi t less drawings less liabilities equals assets.
1.4 An increase in inventories of $250, a decrease in the bank balance of $400 and an
increase in payables of $1,200 results in:
(A) a decrease in working capital of $1,350.
(B) an increase in working capital of $1,350.
(C) a decrease in working capital of $1,050.
(D) an increase in working capital of $1,050.
1.5 A sole trader had opening capital of $10,000 and closing capital of $4,500. During
the period, the owner introduced capital of $4,000 and withdrew $8,000 for her
own use. Her profi t or loss during the period was:
Profi t or loss Amount
$
Revision Questions
2
THE FRAMEWORK OF FINANCIAL STATEMENTS
REVISION QUESTIONS C2
32
1.6 The accounting equation at the start of the month was:
Assets $28,000 less liabilities $12,500
During the following month, the business purchased a non-current asset for $6,000,
paying by cheque, a profi t of $7,000 was made, and payables of $5,500 were paid by
cheque.
Capital at the end of the month would be:
$.......
1.7 The accounting equation can change as a result of certain transactions. Which one of
the following transactions would not affect the accounting equation?
(A) Selling goods for more than their cost.
(B) Purchasing a non-current asset on credit.
(C) The owner withdrawing cash.
(D) Receivables paying their accounts in full, in cash.
1.8 The profi t of a business may be calculated by using which one of the following
formulae?
(A) Opening capital − drawings capital introduced − closing capital.
(B) Closing capital drawings − capital introduced − opening capital.
(C) Opening capital drawings − capital introduced − closing capital.
(D) Closing capital − drawings capital introduced − opening capital.
Question 2
The following table shows the cumulative effects of a series of separate transactions on the
assets and liabilities of a sole trader’s business. The transactions are labelled A to H, and
the fi gures for each asset and liability in the column underneath represent values after the
transaction has taken place.
A B C D E F G H
($) ($) ($) ($) ($) ($) ($) ($) ($)
Non-current assets
Land and
buildings
45,000 65,000 65,000 65,000 65,000 65,000 65,000 65,000 65,000
Equipment 34,000 34,000 34,000 34,000 34,000 34,000 34,000 34,000 34,000
Motor vehicles 17,500 17,500 17,500 17,500 17,500 10,000 10,000 10,000 10,000
Current assets
Inventories 20,800 20,800 20,800 27,000 27,000 27,000 27,000 27,000 23,000
Trade receivables 34,700 34,700 24,700 24,700 24,700 24,700 23,350 23,350 23,350
Prepaid expenses 1,300 1,300 1,300 1,300 1,300 1,300 1,300 1,300 1,300
Cash at bank 2,150 2,150 11,150 11,150 6,400 13,200 13,200 10,200 10,200
Cash on hand 320 320 320 320 320 320 320 320 320
155,770 175,770 174,770 180,970 176,220 175,520 174,170 171,170 167,170
Capital 85,620 85,620 84,620 84,620 84,870 84,170 82,820 79,820 75,820
Loans 50,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000
Current liabilities
Trade payables 18,600 18,600 18,600 24,800 19,800 19,800 19,800 19,800 19,800
Accrued expenses 1,550 1,550 1,550 1,550 1,550 1,550 1,550 1,550 1,550
155,770 175,770 174,770 180,970 176,220 175,520 174,170 171,170 167,170
REVISION QUESTIONS C2
THE FRAMEWORK OF FINANCIAL STATEMENTS
33
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Requirements
Identify, as clearly and as fully as the information permits, what transaction has taken place
in each case by matching the transaction to the description below.
1. A supplier’s invoice for $5,000 is paid by cheque; 5 per cent discount received.
2. An additional non-current loan of $20,000 is raised to fi nance the purchase of addi-
tions/improvements to buildings, costing $20,000.
3. $4,000 of inventories at cost is written off because they are obsolete.
4. A debt of $1,350 due from a customer is written off as bad.
5. $3,000 is withdrawn by the owner from the business bank account for personal use.
6. A customer pays off invoices totalling $10,000 by cheque, and receives 10 per cent
discount.
7. Inventories costing $6,200 are purchased on credit.
8. A motor vehicle stated at $7,500 is sold for $6,800 – the amount being received by
cheque. The resulting loss of $700 reduces capital.
Question 3
You are given the following information relating to a business for the month of May
20XX.
$
Sales of goods for cash 17,000
Sales of goods on credit 28,000
Purchases of inventories on credit 19,500
Wages paid in cash 2,000
Non-current assets bought on credit 12,000
Cash withdrawn by the owner 1,600
Inventories of goods at the start of the period 5,000
Inventories of goods at the end of the period 6,250
Requirement
Complete the following statement to determine the net profi t for the period:
$ $ $
Sales .......... .......... ..........
Less : cost of sales
Opening inventories ..........
Purchases ..........
..........
Closing inventories ..........
Cost of goods sold ..........
Gross profi t ..........
Less : expenses – wages ..........
Net profi t ..........
THE FRAMEWORK OF FINANCIAL STATEMENTS
REVISION QUESTIONS C2
34
Question 4
In addition to the information in Question 3, you are given the following information
regarding assets and liabilities at the start of the period:
$
Non-current assets 37,000
Receivables 7,000
Bank and cash 12,000
Payables 7,300
Requirement
Insert the missing fi gures below to prepare a statement of fi nancial position at the start of
the period.
$
Capital at the start of the period:
Non-current assets ..........
Inventories ..........
Receivables ..........
Bank and cash ..........
Total assets ..........
Less: payables ..........
Capital ..........
Statement of fi nancial position as at 31.5.XX
Assets $$
Non-current assets ..........
Current assets
Inventories ..........
Receivables ..........
Bank and cash ..........
Subtotal ..........
Capital and liabilities
Capital at the start of the period (as per
above)
..........
Net profi t (as per Question 3) ..........
Subtotal ..........
Less : drawings ..........
Capital at the end of the period ..........
Current liabilities: payables ..........
REVISION QUESTIONS C2
35
Solution 1
1.1 Answer: (D)
Working backwards often confuses candidates. Try drawing up a short example of an
income statement using simple fi gures of your own, to prove or disprove the options
given.
For example:
$ $
Sales 20,000
Inventories at 31.12.20X0 2,000
Purchases during 20X1 8,000
10,000
Less : inventories at 31.21.20X1 (1,000)
Cost of goods sold 9,000
Gross profi t 11,000
Less : expenses (4,000)
Net profi t 7,000
Make all the fi gures different or you will make mistakes.
You can now see that options A, B and C will not give the correct answer.
1.2 Answer: (D)
Transactions that affect only assets and liabilities do not affect capital. Therefore,
options A, B and C are irrelevant.
1.3 Answer: (C)
The ‘ standard ’ accounting equation is
Assets Liabilities Capital
and capital equals opening capital plus pr
ofi ts less drawings.
The only rearrangement
of this equation that maintains the integrity of the accounting equation is C.
1.4 Answer: (A)
Solutions to
Revision Questions
2
THE FRAMEWORK OF FINANCIAL STATEMENTS
SOLUTIONS TO REVISION QUESTIONS C2
36
The effect on working capital is calculated as:
$
Increase in inventories increase in working capital 250
Decrease in bank decrease in working capital (400)
Increase in payables decrease in working capital (1,200)
Overall decrease in working capital (1,350)
1.5 Answer:
$
Opening capital 10,000
Introduced 4,000
Drawings (8,000)
Loss − balancing fi gure (1,500)
Closing capital 4,500
1.6 Only the profi t affects the capital at the end of the month. The capital at the start was
$15,500 ($28,000 assets less $12,500 liabilities), so a profi t of $7,000 increases this
to $22,500. The purchase by cheque of a non-current asset affects only assets, and the
payment of payables by cheque affects assets and liabilities, but neither affects capital.
1.7 Answer: (D)
The accounting equation changes when one or more of assets, liabilities or capital
changes. Selling goods at a profi t would change capital; purchasing a non-current asset
on credit would change assets and liabilities; the owner withdrawing cash would change
assets and capital; receivables paying their accounts in cash would not affect any of these.
1.8 Answer: (B)
Solution 2
●
This question requires you to ascertain the reason for changes in the assets and liabilities
as a result of transactions that have occurred.
●
Each column contains two changes that complement each other, because every transac-
tion has two effects.
(A) Answer: 2
(B) Answer: 6
(C) Answer: 7
(D) Answer: 1
(E) Answer: 8
(F) Answer: 4
(G) Answer: 5
(H) Answer: 3
SOLUTIONS TO REVISION QUESTIONS C2
THE FRAMEWORK OF FINANCIAL STATEMENTS
37
FUNDAMENTALS OF FINANCIAL ACCOUNTING
Solution 3
May 20XX $ $
Sales ($17,000 28,000) 45,000
Less : cost of sales
Opening inventories 5,000
Purchases 19,500
24,500
Less: closing inventories (6,250)
18,250
Gross profi t 26,750
Less : expenses – wages (2,000)
Net profi t 24,750
Solution 4
First of all calculate the capital at the start of the period (not forgetting the inventories
balance given in Question 3), then adjust the opening assets and liabilities for the changes
given in Question 3. Finally, add the profi t to the opening capital, and deduct drawings.
$
Non-current assets 37,000
Inventories 5,000
Receivables 7,000
Bank and cash 12,000
61,000
Less : payables (7,300)
Capital 53,700
Statement of fi nancial position as at 31.5.XX
Assets $$
Non-current assets (37,000 12,000) 49,000
Current assets
Inventories 6,250
Receivables (7,000 28,000) 35,000
Bank and cash (12,000 17,000 − 2,000 − 1,600) 25,400
66,650
115,650
Capital and liabilities
Capital at the start of the period (as above) 53,700
Net profi t (as in Question 3) 24,750
78,450
Less : drawings (1,600)
Capital at the end of the period 76,850
Current liabilities
Payables (7,300 19,500 12,000) 38,800
115,650
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3
The Accounting
System in Action